X Ltd is a retail supermarket chain which regularly constructs its own superstores. During the year ending 31 December 1995, X Ltd began work on a new site. On 1 January 1995, a leasehold interest in the site (of 50 years) was purchased for £20 million.It was considered that a further £10 million would be required to build and fit the super- store. £6 million of the additional £10 million would be spent on the construction of the building and £4 million on fixtures and fittings. Past experience has led the management of X Ltd to believe that the fixtures and fittings would have an average useful economic life of ten years from first use before requiring replacement.
On 1 January 1995, X Ltd borrowed £30 million to finance the project. The £30 million carries no interest but is repayable on 31 December 1997 at a premium of £9.93 million (i.e. £39.93 million is to be repaid in total). The superstore is to be brought into use on 1 January 1996.
Requirements
(a) Set out the arguments for and against the capitalisation of borrowing costs on con- structed fixed assets.
(b) Assuming that borrowing costs ARE capitalised where appropriate, calculate:
(i) the total amount to be included in fixed assets in respect of the development at 31 December 1995, and
(ii) the total amount to be charged to the profit and loss account in respect of the development for the year ending 31 December 1996.
Present value factors are shown below.
|
Years t
|
5%
|
Present value of £1 to be received after t years 10%
|
15%
|
|
1
|
0.952
|
0.909
|
0.870
|
|
2
|
0.907
|
0.826
|
0.756
|
|
3
|
0.864
|
0.751
|
0.658
|
|
4
|
0.823
|
0.683
|
0.572
|
|
5
|
0.784
|
0.621
|
0.497
|